How to Optimize Your RRSP to Get a Better Tax Refund

When thinking about possible tax refunds, it is ideal to maximize or optimize it. Especially when it comes to your RRSP contributions.

Most people believe that maximizing and optimizing are the same thing. This, however, is not true. Our Income Tax Preparation firm in Cambridge stresses that these two words are not the same and are used completely different. In concrete terms the results is a big difference in tax refunds.

Let’s talk about “maximizing” first because most people generally opt to maximize their RRSP contributions. An individual maximizes his contributions by remitting more than the minimum required for a fiscal year. In investment language, this is putting a “top up” to the contribution. In 2014, the maximum contribution that one can make is $22,000. People are allowed to contribute as much as 18% of their previous year’s income – and that can be lower than $22,000.

For those who can afford to contribute more, topping up is a good idea since they know they will benefit more in later years – especially during their retirement. Still, the question of whether to add more money to the RRSP contribution given one’s limited income at the moment weighs down heavily on just about every RRSP contributor’s mind.

In optimizing, the person still tries to maximize his RRSP contribution – but with a twist. The individual will not be shelling out 18% from his previous year’s gross income. Instead, he will be borrowing money. The sum he will borrow will be paid for by an equivalent amount in tax refund the following year. In effect, he was able to maximize his RRSP contribution by as much as 30% without having to shell out a single cent. Now that’s what we mean by optimizing.

Here is a simple explanation to show what we mean by optimizing your RRSP contribution: Suppose your RRSP contribution for 2014 is $8,000 and your income is bracketed at a 30% marginal tax rate. You then have the option to borrow as much as $3,425 to top-up your contribution. Thus your 2014 RRSP contribution would be $11,425 – instead of just $8,000. Now, since you are bracketed at a 30% marginal tax rate, you will be entitled to a tax refund of $3,427. You have paid your loan with your refund. You have increased your RRSP contribution without shelling out one cent from your income. Now, that’s what we mean by optimizing.

Let me stress that this example uses simple figures. The results from actual contributions may be different – but not by much. The important thing to note is the concept: Borrow enough money to top-up your RRSP contribution and let your tax refund pay your loan. You don’t shell out a cent to top-up your RRSP contribution.

Our income tax preparation team in Cambridge, ON notes not everything is about maximizing your tax refund in the future. You don’t have to worry about getting a lot out of your present savings in order to maximize your RRSP contribution. You do however get the most out of everything that way: your present income, your tax refund and your RRSP contribution.